The Bank of Canada has issued guidelines for the first time on how it plans to eventually scale back monetary stimulus, saying it will raise interest rates first before reducing its holdings of government bonds.
In a speech on Thursday the day after a firm decision, Governor Tiff Macklem provided details on what he called the “central bank’s monetary policy for the recovery.” Macklem reiterated that the bank intends to bring its bond purchases back to a roughly neutral pace where holdings and stimulus levels remain stable, and to maintain this for a “period of time” before starting to withdraw extraordinary support for the economy.
And when policymakers begin to scale back that stimulus, the first step will be to raise the central bank’s key interest rate rather than cut bond holdings, Macklem said.
“When we need to reduce the amount of monetary stimulus, you can expect us to start by raising our key interest rate,” Macklem said in prepared remarks for a virtual speech at the Quebec Chamber of Commerce. . “What all of this means is that it’s reasonable to expect that when we hit the reinvestment phase, we’ll stay there for some time, at least until we increase the rate of reinvestment. guiding interest.”
The Bank of Canada has used two major tools to keep borrowing costs low: keeping its key overnight rate near zero and buying hundreds of billions of government bonds from investors to control long-term borrowing costs.
The central bank has already purchased about $336 billion (US$266 billion) of Canadian government bonds under its asset purchase program, also known as quantitative easing. It started buying $5 billion a week initially, but has since scaled back those purchases three times to bring it to the current target of $2 billion a week.
Raising interest rates while reducing bond holdings at the same time threatens to be too strong a stimulus withdrawal.
“It’s important because we’ve typically seen other central banks stop buying and allow the balance sheet to start rolling during rate hikes,” head of securities research Ian Pollick said in an email. fixed income, currencies and commodities at the Canadian Imperial Bank of Commerce. “It’s almost like you’re doubling down on the takedown of the raise.”
Macklem’s roadmap is in line with what economists and markets were anticipating – a final cut later this year to bring net bond purchases down to around zero, followed by a first rate hike later in 2022. Swap trading suggests investors are priced within a 100 percent chance of a move higher over the next 12 months. Three hikes over the next two years are fully factored in, which would leave Canada with the highest policy rate among the Group of Seven economies.
The Canadian currency was little changed after the speech, having gained around 0.5% earlier in the day.
In his remarks, Macklem said the central bank estimates that it will need to continue buying about $1 billion a week in government bonds in order to keep its holdings at stable levels during the reinvestment phase, or about 4 to $5 billion a month. The reduction in purchases will take place in both the primary and secondary markets, he said.
“Eventually, the reinvestment phase will end and we will stop buying bonds to replace maturing ones, so our holdings of Government of Canada bonds will decrease,” Macklem said. “It is reasonable to expect that when we finally need to reduce monetary stimulus, our first decision will be to raise the target for the overnight rate, our key interest rate.”
In its rate statement on Wednesday, the bank stuck to its target of keeping its benchmark rate at 0.25% until the economy is fully recovered and inflation is sustainably back to 2%, which ‘she doesn’t see it happening until the second half of next year. .
On Thursday, Macklem pointed out that the recovery is progressing as vaccination rates allow businesses to reopen. However, he reiterated that a number of hurdles remained, with supply chain issues weighing on exports and manufacturing, and the trajectory of the virus and its variants still unclear.
“This is real progress, even if the recovery remains choppy and we are still living with the virus and uncertainty about its course,” Macklem said.